T-1 Capacity Market clears below expectations

Alan Richards -
The T-1 Capacity Market auction closed at just £6.95/kW last week, less than half of analyst’s forecasts. This compared with £19.40/kW, £18/kW and £22.50/kW in the T-4 auctions held between 2014 and last year for capacity delivery four years ahead. These were also well below expectations and have so far failed to deliver adequate funding for new large scale thermal plants at a time when the industry is facing the mandatory closure of all the UK existing coal plant by 2025 and then all but one of the UK’s existing nuclear plants are due to close by 2030. This amounts to around 28% of installed capacity closing in the next 13 years.

Last week’s auction was the first Capacity Market auction for year-ahead delivery and was introduced early to replace the National Grid’s Supplementary Balancing Reserve next winter. The low prices being reached at the auctions is developing into a running theme as it appears the auctions are being flooded by existing capacity which is crowding out new plants which need to bid at higher prices to cover capital costs.

The low prices are however reducing costs for end-users as the Capacity payments are recovered by the operator through additional charges to the end-user. This charge is applied during the 4-7pm peak between November and February and the £6.95/KW price recently struck will add around £26/MWh to charging at the time, on top of Red-Rate charges, from next winter. This will then increase to £65/MWh the following year.

This however comes with a catch. Wholesale prices rallied significantly this winter following the closure of three large coal plants last summer which have left supply margins considerably tighter. When the nuclear outages in France then forced up Continental prices and resulted in the IFR Interconnector flipping from the usual net imports of 2GW to net exports of the same volume, the UK system struggled to cope, sending prices rocketing.

Given the scale of closures looming, new large thermal plants will be needed. There is a growing focus on Demand Side Management and Response and also smaller embedded capacity which is contributing to reducing peak demand, but this is unlikely to be enough to replace the 21GW of capacity closing in the next 17 years.

So what is being done to remove the overcrowding in the Capacity Market? Ofgem is looking at ways to remove smaller embedded generators, who also receive embedded benefits — such as Triad Avoidance, generator DNUoS and BSUoS benefit — from receiving the Capacity Market support as well. So far however, a proposal to halt access to both embedded benefits and Capacity Market payments has been rejected by Ofgem, who argued that an overall review of the Connection and Use of System Code charging will be needed instead.

It is not certain when this review will be completed, but some clarity will be needed to ensure the investment is made. Given the scale of closures looming it will likely take a combination of decentralised approaches, such as Demand Side Management, and also a traditional centralised approach of building new large-scale thermal capacity.